Micro Finance Kothari

8/6/2019 Micro Finance Kothari

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MICROFINANCE IN INDIA: A DETAILED STUDY

Kamir Kothari

[email protected]

VIT University, India

Ph: +9047287528

Devanik Saha

[email protected]

VIT University, India

Ph: +919952112882

1. Introduction

Microfinance is defined as any activity that includes the provision of financial

services such as credit, savings, and insurance to low income individuals which fall just above the nationally defined poverty line, and poor individuals which fall below

that poverty line, with the goal of creating social value. The creation of social value

includes poverty alleviation and the broader impact of improving livelihood

opportunities through the provision of capital for micro enterprise, and insurance and

savings for risk mitigation and consumption smoothing. A large variety of actors

provide microfinance in India, using a range of microfinance delivery methods. Since

the founding of the Grameen Bank in Bangladesh, various actors have endeavored to

provide access to financial services to the poor in creative ways. Governments have

piloted national programs, NGOs have undertaken the activity of raising donor funds

for on-lending, and some banks have partnered with public organizations or made

small inroads themselves in providing such services. This has resulted in a rather

broad definition of microfinance as any activity that targets poor and low-income

mailto:[email protected]








individuals for the provision of financial services. The range of activities undertaken

in microfinance include group lending, individual lending, the provision of savings

and insurance, capacity building, and agricultural business development services.

Whatever the form of activity however, the overarching goal that unifies all actors in

the provision of microfinance is the creation of social value.

2. Activities in Microfinance

Micro credit: It is a small amount of money loaned to a client by a bank or other

institution. Micro credit can be offered, often without collateral, to an individual or

through group lending.

Micro savings: These are deposit services that allow one to save small amounts of

money for future use. Often without minimum balance requirements, these savings

accounts allow households to save in order to meet unexpected expenses and plan for

future expenses.

Micro insurance: It is a system by which people, businesses and other organizations

make a payment to share risk. Access to insurance enables entrepreneurs to

concentrate more on developing their businesses while mitigating other risks affecting

property, health or the ability to work.

Remittances: These are transfer of funds from people in one place to people in

another, usually across borders to family and

Friends. Compared with other sources of capital that can fluctuate depending on the

political or economic climate, remittances are a relatively steady source of funds.

3. Legal Regulations

Banks in India are regulated and supervised by the Reserve Bank of India (RBI) under

the RBI Act of 1934, Banking Regulation Act, Regional Rural Banks Act, and the

Cooperative Societies Acts of the respective state governments for cooperative banks.



NBFCs are registered under the Companies Act, 1956 and are governed under the

RBI Act. There is no specific law catering to NGOs although they can be registered

under the Societies Registration Act, 1860, the Indian Trust Act, 1882, or the relevant

state acts. There has been a strong reliance on self-regulation for NGO MFIs and as

this applies to NGO MFIs mobilizing deposits from clients who also borrow. This

tendency is a concern due to enforcement problems that tend to arise with self-

regulatory organizations. In January 2000, the RBI essentially created a new legal

form for providing microfinance services for NBFCs registered under the Companies

Act so that they are not subject to any capital or liquidity requirements if they do not

go into the deposit taking business. Absence of liquidity requirements is concern to

the safety of the sector.

4. Microfinance in India

At present lending to the economically active poor both rural and urban is pegged at

around Rs 7000 crores in the Indian banks’ credit outstanding. As against this,

according to even the most conservative estimates, the total demand for credit

requirements for this part of Indian society is somewhere around Rs 2,00,000 crores.

Deprived of the basic banking facilities, the rural and semi urban Indian masses are

still relying on informal financing intermediaries like money lenders, family

members, friends etc.

4.1 Distribution of Indebted Rural Households: Agency wise



Credit Agency Percentage of

Rural Households

Government 6.1

Cooperative

Societies

21.6

Commercial banks

and RRBs

33.7

Insurance 0.3

Provident Fund 0.7

Other Institutional

Sources

1.6

All Institutional

Agencies

64.0

Landlord 4.0

Agricultural

Moneylenders

7.0

Professional

Moneylenders

10.5

Relatives and

Friends

5.5

Others 9.0

All Non

Institutional

Agencies

36.0

All Agencies 100.0

Source: Debt and Investment Survey, GoI 1992



Seeing the figures from the above table, it is evident that the share of institutional

credit is much more now.

The above survey result shows that till 1991, institutional credit accounted for around

two-thirds of the credit requirement of rural households. This shows a comparatively

better penetration of the banking and financial institutions in rural India.

Percentage distribution of debt among indebted Rural Labor Households by

source of debt

Households Sr.

No.

Source of debt

With

cultivated

land

Without

cultivated

land

All

1 Government 4.99 5.76 5.37

2 Co-operative

Societies

16.78 9.46 13.09

3 Banks 19.91 14.55 17.19

4 Employers 5.35 8.33 6.86

5 Money lenders 28.12 35.23 31.70

6 Shop-keepers 6.76 7.47 7.13

7 Relatives/Friends 14.58 15.68 15.14

8 Other Sources 3.51 3.52 3.52

Total 100.00 100.00 100.00



Source: Rural labor enquiry report on indebtedness among rural labor

households (55th Round of N.S.S.) 1999-2000

The table above reveals that most of the rural labour households prefer to raise loan

from the non-institutional sources. About 64% of the total debt requirement of these

households was met by the non-institutional sources during 1999-2000. Money

lenders alone provided debt (Rs.1918) to the tune of 32% of the total debt of these

households as against 28% during 1993-94. Relatives and friends and shopkeepers

have been two other sources which together accounted for about 22% of the total debt

at all-India level.

The institutional sources could meet only 36% of the total credit requirement of therural labour households during 1999-2000 with only one percent increase over the

previous survey in 1993-94. Among the institutional sources of debt, the banks

continued to be the single largest source of debt meeting about 17 percent of the total

debt requirement of these households. In comparison to the previous enquiry, the

dependence on co-operative societies has increased considerably in 1999-2000.

During 1999-2000 as much as 13% of the debt was raised from this source as against

8% in 1993-94. However, in the case of the banks and the government agencies itdecreased marginally from 18.88% and 8.27% to 17.19% and 5.37% respectively

during 1999-2000 survey.

4.2 Relative share of Borrowing of Cultivator Households (in per cent)

Sources of Credit

1951 1961 1971 1981 1991 2002

*

Non

Institutional

92.7 81.3 68.3 36.8 30.6 38.9

Of which:



Moneylenders 69.7 49.2 36.1 16.1 17.5 26.8

Institutional 7.3 18.7 31.7 63.2 66.3 61.1

Of which:

Cooperative

Societies,etc

3.3 2.6 22.0 29.8 30.0 30.2

Commercial

banks

0.9 0.6 2.4 28.8 35.2 26.3

Unspecified - - - - 3.1 -

Total 100.0 100.0 100.0 100.0 100.0 100.0

* All India Debt and Investment Survey, NSSO, 59th round, 2003

Source: All India Debt and Investment Surveys

Table shows the increasing influence of moneylenders in the last decade. The share of

moneylenders in the total non institutional credit was declining till 1981, started

picking up from the 1990s and reached 27 per cent in 2001.

At the same time the share of commercial banks in institutional credit has come down

by almost the same percentage points during this period. Though, the share of

cooperative societies is increasing continuously, the growth has flattened during the

last three decades.

4.3 Distribution based on Asset size of Rural Households (in per cent)

Household

Assets (Rs

‘000)

Institutional

Agency

Non-

Institutional

Agency

All

Less than

5

42 58 100



5-10 47 53 100

10-20 44 56 100

20-30 68 32 100

30-50 55 45 100

50-70 53 47 100

70-100 61 39 100

100-150 61 39 100

150-250 68 32 100

250 and

above

81 19 100

All classes 66 34 100

Source: Debt and Investment Survey, GoI, 1992

The households with a lower asset size were unable to find financing options from

formal credit disbursement sources. This was due to the requirement of physical

collateral by banking and financial institutions for disbursing credit. For households

with less than Rs 20,000 worth of physical assets, the most convenient source of

credit was non institutional agencies like landlords, moneylenders, relatives, friends,

etc.

Looking at the findings of the study commissioned by Asia technical Department of

the World Bank (1995), the purpose or the reason behind taking credit by the rural

poor was consumption credit, savings, production credit and insurance.

Consumption credit constituted two-thirds of the credit usage within which almost

three-fourths of the demand was for short periods to meeting emergent needs such as

illness and household expenses during the lean season. Almost entire demand for the

consumption credit was met by informal sources at high to exploitive interest rates

that varied from 30 to 90 per cent per annum.



Almost 75 per cent of the production credit (which accounted for about one-third of

the total credit availed of by the rural masses) was met by the formal sector, mainly

banks and cooperatives.

5. Microfinance Social Aspects

Micro financing institutions significantly contributed to gender equality and women’s

empowerment as well as pro poor development and civil society strengthening.

Contribution to women’s ability to earn an income led to their economic

empowerment, increased well being of women and their families and wider social and

political empowerment.

Microfinance programs targeting women became a major plank of poverty alleviation

and gender strategies in the 1990s. Increasing evidence of the centrality of gender

equality to poverty reduction and women’s higher credit repayment rates led to a

general consensus on the desirability of targeting women.

6. Micro Finance Models

6.1 Micro Finance Institutions (MFIs):

MFIs are an extremely heterogeneous group comprising NBFCs, societies, trusts and

cooperatives. They are provided financial support from external donors and apex

institutions including the Rashtriya Mahila Kosh (RMK), SIDBI Foundation for

micro-credit and NABARD and employ a variety of ways for credit delivery.

Since 2000, commercial banks including Regional Rural Banks have been providing

funds to MFIs for on lending to poor clients. Though initially, only a handful of

NGOs were “into” financial intermediation using a variety of delivery methods, their

numbers have increased considerably today. While there is no published data on

private MFIs operating in the country, the number of MFIs is estimated to be around

800.



Legal Forms of MFIs in India

Types of

MFIs

Estimated

Number*

Legal Acts

under which

Registered

1. Not for

Profit MFIs

a.) NGO -

MFIs

400 to 500 Societies

Registration

Act, 1860 or

similar

Provincial

Acts

Indian Trust

Act, 1882

b.) Non-profit

Companies

10 Section 25 of

the Companies

Act, 1956

2. Mutual

Benefit MFIs

a.) Mutually

Aided

Cooperative

Societies

(MACS) and

similarly set up

institutions

200 to 250 Mutually

Aided

Cooperative

Societies Act

enacted by

State

Government

3. For Profit

MFIs

a.) Non-

Banking

6 Indian

Companies

Act, 1956

Reserve Bank



Financial

Companies

(NBFCs)

of India Act,

1934

Total 700 - 800

Source: NABARD website

6.2 Bank Partnership Model

This model is an innovative way of financing MFIs. The bank is the lender and the

MFI acts as an agent for handling items of work relating to credit monitoring,supervision and recovery. In other words, the MFI acts as an agent and takes care of

all relationships with the client, from first contact to final repayment. The model has

the potential to significantly increase the amount of funding that MFIs can leverage

on a relatively small equity base.

A sub - variation of this model is where the MFI, as an NBFC, holds the individual

loans on its books for a while before securitizing them and selling them to the bank.

Such refinancing through securitization enables the MFI enlarged funding access. If

the MFI fulfils the “true sale” criteria, the exposure of the bank is treated as being to

the individual borrower and the prudential exposure norms do not then inhibit such

funding of MFIs by commercial banks through the securitization structure.

6.3 Banking Correspondents

The proposal of “banking correspondents” could take this model a step further

extending it to savings. It would allow MFIs to collect savings deposits from the poor

on behalf of the bank. It would use the ability of the MFI to get close to poor clients

while relying on the financial strength of the bank to safeguard the deposits. This

regulation evolved at a time when there were genuine fears that fly-by-night agents

purporting to act on behalf of banks in which the people have confidence could



mobilize savings of gullible public and then vanish with them. It remains to be seen

whether the mechanics of such relationships can be worked out in a way that

minimizes the risk of misuse.

6.4 Service Company Model

Under this model, the bank forms its own MFI, perhaps as an NBFC, and then works

hand in hand with that MFI to extend loans and other services. On paper, the model is

similar to the partnership model: the MFI originates the loans and the bank books

them. But in fact, this model has two very different and interesting operational

features:

(a) The MFI uses the branch network of the bank as its outlets to reach clients. This

allows the client to be reached at lower cost than in the case of a stand–alone MFI. In

case of banks which have large branch networks, it also allows rapid scale up. In the

partnership model, MFIs may contract with many banks in an arms length

relationship. In the service company model, the MFI works specifically for the bank

and develops an intensive operational cooperation between them to their mutual

advantage.

(b) The Partnership model uses both the financial and infrastructure strength of the

bank to create lower cost and faster growth. The Service Company Model has the

potential to take the burden of overseeing microfinance operations off the

management of the bank and put it in the hands of MFI managers who are focused on

microfinance to introduce additional products, such as individual loans for SHG

graduates, remittances and so on without disrupting bank operations and provide a

more advantageous cost structure for microfinance.

7. The BANDHAN MODEL

Bandhan is working towards the twin objective of poverty alleviation and women

empowerment. It started as a Capacity Building Institution (CBI) in November 2000



under the leadership of Mr. Chandra Shekhar Ghosh. During such time, it was giving

capacity building support to local microfinance institutions working in West Bengal.

Bandhan opened its first microfinance branch at Bagnan in Howrah district of West

Bengal in July 2002. Bandhan started with 2 branches in the year 2002-03 only in the

state of West Bengal and today it has grown as strong as 412 branches across 6 states

of the country! The organization had recorded a growth rate of 500% in the year

2003-04 and 611% in the year 2004-05. Till date, it has disbursed a total of Rs. 587

crores among almost 7 lakh poor women. Loan outstanding stands at Rs. 221 crores.

The repayment rate is recorded at 99.99%. Bandhan has staff strength of more than

2130employees.

As on July 2008

No. of states

No. of branches

No. of members

No. of staff

Cumulative loan

disbursed

Loan outstanding

: 8

: 528

: 1,182,741

: 3,191

: Rs.1,249

crores

: Rs. 417 crores

Operational Methodology

Bandhan follows a group formation, individual lending approach. A group of 10-25

members are formed. The clients have to attend the group meetings for 2 successive

weeks. 2 weeks hence, they are entitled to receive loans. The loans are disbursed



individually and directly to the members.

Economic and Social Background of Clients

o Landless and asset less women

o Family of 5 members with monthly income less than Rs. 2,500 in rural

and Rs. 3,500 in urban

o Those who do not own more than 50 decimal (1/2acre) of land or

capital of its equivalent value

Loan Size

The first loan is between Rs. 1,000 – Rs. 7,000 for the rural areas and between Rs.

1,000 – Rs. 10,000 for the urban areas. After the repayment, they are entitled to

receive a subsequent loan which is Rs 1,000 - 5,000 more than the previous loan.

Service Charge

Bandhan charges a service charge of 12.50% flat on loan amount. Bandhan initially

charged 17.50%. However from 1st July 2005, it has slashed down its lending rate to

15.00%. Then it was further reduced to 12.50% in May 2006. The reason is obvious.

As overall productivity increased, operational costs decreased. Bandhan, being a non

profit organization wanted the benefit of low costs to ultimately trickle down to the

poor.

Monitoring System

The various features of the monitoring system are:



o A 3 tier monitoring system – Region, Division and Head Office

o Easy reporting system with a prescribed checklist format

o Accountability at all levels post monitoring phase

o Cross- checking at all the levels

o The management team of Bandhan spends 90.00% of time at the field

Liability structure for Loans

When a member wants to join Bandhan, she at first has to get inducted into a group.

After she gets inducted into the group, the entire group proposes her name for a loanin the Resolution Book. Two members of the group along with the member’s husband

have to sign as guarantors in her loan application form. If she fails to pay her weekly

installment, the group inserts peer pressure on her. The sole purpose of the above

structure is simply to create peer pressure.

8. Grameen Bank Model

The Grameen Model which was pioneered by Prof Muhammed Yunus of Grameen

Bank is perhaps the most well known, admired and practised model in the world. The

model involves the following elements.

! Homogeneous affinity group of five

! Eight groups form a Centre

! Centre meets every week

! Regular savings by all members

! Loan proposals approved at Centre meeting



! Loan disbursed directly to individuals

! All loans repaid in 50 installments

The Grameen model follows a fairly regimented routine. It is very cost intensive as it

involves building capacity of the groups and the customers passing a test before the

lending could start. The group members tend to be selected or at least strongly vetted

by the bank. One of the reasons for the high cost is that staff members can conduct

only two meetings a day and thus are occupied for only a few hours, usually early

morning or late in the evening. They were used additionally for accounting work, but

that can now be done more cost effectively using computers. The model is also rather

meeting intensive which is fine as long as the members have no alternative use fortheir time but can be a problem as members go up the income ladder.

The greatness of the Grameen model is in the simplicity of design of products and

delivery. The process of delivery is scalable and the model could be replicated

widely. The focus on the poorest, which is a value attribute of Grameen, has also

made the model a favourite among the donor community.

However, the Grameen model works only under certain assumptions. As all the loans

are only for enterprise promotion, it assumes that all the poor want to be self-

employed. The repayment of loans starts the week after the loan is disbursed – the

inherent assumption being that the borrowers can service their loan from the ex-ante

income.

9. Success Factors of Micro-Finance in India

Over the last ten years, successful experiences in providing finance to small

entrepreneur and producers demonstrate that poor people, when given access to

responsive and timely financial services at market rates, repay their loans and use the

proceeds to increase their income and assets. This is not surprising since the only



realistic alternative for them is to borrow from informal market at an interest much

higher than market rates. Community banks, NGOs and grass root savings and credit

groups around the world have shown that these microenterprise loans can be

profitable for borrowers and for the lenders, making microfinance one of the most

effective poverty reducing strategies.

A. For NGOs

1. The field of development itself expands and shifts emphasis with the pull of

ideas, and NGOs perhaps more readily adopt new ideas, especially if the

resources required are small, entry and exit are easy, tasks are (perceived to

be) simple and people’s acceptance is high – all characteristics (real orpresumed) of microfinance.

2. Canvassing by various actors, including the National Bank for Agriculture

and Rural Development (NABARD), Small Industries Development Bank of

India (SIDBI), Friends of Women’s World Banking (FWWB), Rashtriya

Mahila Kosh (RMK), Council for Advancement of People’s Action and Rural

Technologies (CAPART), Rashtriya Gramin Vikas Nidhi (RGVN), various

donor funded programmes especially by the International Fund for

Agricultural Development (IFAD), United Nations Development Programme

(UNDP), World Bank and Department for International Development, UK

(DFID)], and lately commercial banks, has greatly added to the idea pull.

Induced by the worldwide focus on microfinance, donor NGOs too have been

funding microfinance projects. One might call it the supply push.

3. All kinds of things from khadi spinning to Nadep compost to balwadis do not

produce such concrete results and sustained interest among beneficiaries as



microfinance. Most NGO-led microfinance is with poor women, for whom

access to small loans to meet dire emergencies is a valued outcome. Thus,

quick and high ‘customer satisfaction’ is the USP that has attracted NGOs to

this trade.

4. The idea appears simple to implement. The most common route followed by

NGOs is promotion of SHGs. It is implicitly assumed that no ‘technical skill’

is involved. Besides, external resources are not needed as SHGs begin with

their own savings. Those NGOs that have access to revolving funds from

donors do not have to worry about financial performance any way. Thechickens will eventually come home to roost but in the first flush, it seems all

so easy.

5. For many NGOs the idea of ‘organising’ – forming a samuha – has inherent

appeal. Groups connote empowerment and organising women is a double

bonus.

6. Finally, to many NGOs, microfinance is a way to financial sustainability.

Especially for the medium-to-large NGOs that are able to access bulk funds

for on-lending, for example from SIDBI, the interest rate spread could be an

attractive source of revenue than an uncertain, highly competitive and

increasingly difficult-to-raise donor funding.

B. For Financial Institutions and banks



Microfinance has been attractive to the lending agencies because of demonstrated

sustainability and of low costs of operation. Institutions like SIDBI and NABARD are

hard nosed bankers and would not work with the idea if they did not see a long term

engagement – which only comes out of sustainability (that is economic

attractiveness).

On the supply side, it is also true that it has all the trappings of a business enterprise,

its output is tangible and it is easily understood by the mainstream. This also seems to

sound nice to the government, which in the post liberalisation era is trying to explain

the logic of every rupee spent. That is the reason why microfinance has attractedmainstream institutions like no other developmental project.

Perhaps the most important factor that got banks involved is what one might call the

policy push.

Given that most of our banks are in the public sector, public policy does have some

influence on what they will or will not do. In this case, policy was followed by

diligent, if meandering, promotional work by NABARD. The policy change about a

decade ago by RBI to allow banks to lend to SHGs was initially followed by a seven-

page memo by NABARD to all bank chairmen, and later by sensitisation and training

programmes for bank staff across the country. Several hundred such programmes

were conducted by NGOs alone, each involving 15 to 20 bank staff, all paid for by

NABARD. The policy push was sweetened by the NABARD refinance scheme that

offers much more favourable terms (100% refinance, wider spread) than for other

rural lending by banks. NABARD also did some system setting work and banks lately

have been given targets. The canvassing, training, refinance and close follow up by

NABARD has resulted in widespread bank involvement.

Moreover, for banks the operating cost of microfinance is perhaps much less than for

pure MFIs. The banks already have a vast network of branches. To the extent that an



mainstreaming is a mixed blessing, and one tends to exchange scale at the cost of

objectives. So it needs to be watched carefully.

References

1. Anil K Khandelwal, “Microfinance Development Strategy for India”,

Economic and Political Weekly, March 31, 2007

2. Nachiket Mor, Bindu Ananth, “Inclusive Financial Systems- Some Design

Principles and a case study”, Economic and Political Weekly, March 31,

2007

3. Vikram Akula, “Business Basics at the Base of the Pyramid”, Harvard

Business Review, June, 20084. EDA Rural Syatems Pvt Ltd in association with APMAS, “Self Help Groups

in India- A Study of the Light and Shades”

5. Raven Smith, “ The Changing Face of Microfinance in India- The costs and

benefits of transforming from an NGO to a NBFC”, 2006

6. R Srinivasan and M S Sriram, “Microfinance in India- Discussion”

7. Piyush Tiwari and S M Fahad, HDFC, “Concept paper- Microfinance

Institutions in India”8. Barbara Adolph,DFID, “Rural Non Farm Economy: Access Factors”,

February, 2003

9. Shri Y S P Thorat, Managing Director, NABARD, “Innovation in Product

Design, Credit Delivery and Technology to reach small farmers”, November,

2005

10. Shri Y S P Thorat, Managing Director, NABARD, “Microfinance in India:

Sectoral Issues and Challenges”, May, 2005

11. Dr. C Rangarajan, Chairman, Economic Advisory Council to the Prime

Minister, “Microfinance and its Future Directions”, May, 2005

Micro Finance Kothari

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